Various financial vehicles exist to aid in investing. For example, mutual funds are accounts that are professionally managed by portfolio mangers on behalf of many mutual-fund holders. Each shareholder participates in the gain or loss of the fund. Shares are issued and can be redeemed as needed. Mutual funds give small investors access to a well-diversified portfolio of equities, bonds, and other securities; however, the individual preferences of a single investor in a mutual fund are not taken into account. For example, since a mutual fund is managed as a single portfolio in a single account, the portfolio manager needs only to create trades in a single account to affect the investment of the mutual fund, thereby affecting the exposure for example of thousands or tens of thousands of clients.
In contrast to a mutual fund, a managed account is an investment account that is owned by an individual investor and looked after by a professional money manager. In contrast to mutual funds, managed accounts are personalized investment portfolios tailored to the specific needs of the account holder; however, a successful professional money manager is called upon to manage a large number of portfolios. When called upon to manage large numbers of managed accounts an investment manager encounters significant scalability challenges. In addition, without adequate controls in place the investment manager is unable to properly oversee that each account is adhering to a specific client's needs, goals, and constraints in a timely fashion.
One attempt to enable an investment manager to support thousands of managed accounts is a “model portfolio” (or “model”). The predominant type of model used for managed accounts is a “specific security model” (or “security model”). A security model lists a set of specific securities, each with a target position weight. By security, what is meant is an instrument representing ownership (stocks), a debt agreement (bonds), the rights to ownership (derivatives), and the like. Examples of securities can include a note, stock, preferred share, bond, debenture, option, future, swap, right, warrant or virtually any other financial asset.
Alternatively, a high-net worth manager will manage individual clients, but must manage these accounts in accordance with the guidelines of the firm. For example, to balance out risk exposure in the financial markets, an investment management firm may require that individual managers ensure that a client holds a certain amount in a specific set of asset classes. Since the manager is picking individual securities for a client, a specific security model cannot be used by the firm to dictate that a manager's model does not violate a firm's guidelines. This could open up the firm to potential financial liability if a client loses money due to their account being over exposed to a specific asset class. Since a firm can have hundreds or thousands of individual managers managing hundreds of accounts, this exposure creates a significant operational challenge. Firms can run a periodic analysis of a client's holdings to see if there are any violations that are occurring; however, this is a reactionary approach that still can hold the firm responsible for any financial costs in fixing a client's account.
Accordingly, there are several challenges facing investment managers who manage large numbers of managed accounts following a model-based approach. For example, in such managed accounts, high net worth accounts, institutional accounts, and the like, the size of a given trade orders can become big enough to impact the market. The ability for large trades to impact the market means that accounts that trade first can receive better pricing than accounts that trade later on. If a specific account is always trading first, then that account likely will always get the best prices for its trades, thus violating the principle of treating investors fairly. This is in contrast to retail accounts, where the size of a single trade order is not big enough to have an impact on the market.
This is an example of treating investors fairly. Treating investors fairly is a critical concept for the securities industry. If investors start to feel that they are disadvantages relative to other investors, their faith in the market will be impacted. This lack of faith could result in an unwillingness to invest. If this attitude became widely held, it would be the end of the market since the market cannot survive without investors.
A number of securities laws are written to specifically ensure investor fairness. In some cases, these laws prescribe specific types of rules to ensure fairness; in other cases, the laws prescribe the types of data that must be publicly available to allow investors to verify that they are being treated fairly. Compliance officers at investment companies are responsible for establishing corporate policies to ensure that personnel operate in a way to comply with the law. Some of these policies are design to comply with the letter of the law; others are design to comply with spirit of the law.
In addition, trade rotation is a common policy found at many investment companies. The rationale for trade rotation is to ensure that investors are treated equally. The goal behind any trade rotation policy is to establish a mechanism to ensure that accounts are treated fairly during trade processing. Typically, rotation policies establish a rotating sequence number scheme. Each trade is assigned a sequence number and the sequence number is used to govern how the trade is processed. Due to the complexity of the trading process, there are a number of ways that this sequence number can be used. Trade rotation policies also vary depending on the type of organization performing the trades.
Buy-side firms are responsible for sending trades to various executing brokers to service their accounts. Some accounts have directives that require trades to be sent to a specific executing broker. Other accounts give the firm discretion regarding the brokers they are allowed to use. Typically, a buy-side firm will aggregate trades with similar characteristics and send the order for multiple accounts together. This blocking of smaller trades into a large trade is done to provide better pricing in the market.
In one scenario, a firm will have multiple similar trades that need to be sent to multiple executing brokers. To ensure investor fairness, the trade rotation policy defines sequencing scheme for executing brokers that must be followed when sending trades to different executing brokers. In another scenario, the buy-side firm aggregates trades across accounts and, instead of sending the trades to multiple executing brokers, will “step-out” or “trade away” the trades to a single broker. This stepped-out trade will then be allocated back to the underlying accounts. Since it is possible that the entire trade amount will not be filled at the end of a trading day, some trade rotation policies define a sequence that defines how a “trade-away” trade is allocated back to the underlying accounts. In another scenario, buy-side firms have trades that have been aggregated by product (e.g., mutual fund trades, institutional trades, and managed account trades). In this scenario, trade rotation policies can determine which product trades first in the market or, if the product-level trades are aggregated and released to the market together, how the executions will be allocated back to the individual products.
Sell-side firms have a slightly different issue. Sell-side firms receive trades from multiple buy-side firms. Thus, sell-side firms need to ensure that buy-side firms are treated fairly. In one scenario, trade rotation policies at sell-side firms determine the sequence for processing trades from buy-side firms. This sequence number ensures that buy-side firms have the opportunity to trade first with their orders. In another scenario, the sell-side firm may aggregate the trades from multiple buy-side firms together. In this scenario, the trade rotation policy governs how executions are allocated to fill the trades requested by the buy-side firms.
Order management systems in the prior art are good at handling the common trading flows that are found with traditional institutional accounts and mutual fund accounts. However, trade order management systems in the prior art are not good at dealing with more specialize scenarios associated with managed accounts and types of accounts in the wealth management segment. Since the current tools do not support the specialized scenarios, the trades in dealing with these types of scenarios perform the work manually. This manual effort is a major source of inefficiency and errors and greatly increases the cost of dealing with these types of accounts. In addition, the prior art systems also can allow traders to manipulate the trade rotation and the trade rotation can be difficult to document, thus violating the trading fairness doctrine.